Seal of the United States Department of the Treasury (Photo credit: Wikipedia)

The real challenge and issue:

The US Debt default that is looming ever larger with each passing day that the US Congress, Senate and White House seem to treat as a brinkmanship fatigue challenge will have a specific default structure or process attached to it, that the rest of the world needs to get to grips with very quickly.

Breakdown of political party representation in the United States Senate during the 112th Congress. Blue: Democrat Red: Republican Light Blue: Independent (caucused with Democrats) (Photo credit: Wikipedia)

What are the consequences:

Because, if Americans are willing to engage in quasi-negotiations with each other on this acrimonious level; then world beware, they will treat you with even more disdain and petulance than they have been treating each other.

And yet, no Creditor Nation of the USA seem in the least bit prepared for the hard bargaining the USA Treasury officials will engage in when the technical default moves into a more serious phase.

This is commercial war on a scale we have not experienced for quite some time.

And the most disparaging part of this process or potential risk is that no commentator has yet stood up and called time on this challenge or at the very least attempted to pull the veil from the threat and fall-out the rest of the world will experience.

The western front of the United States Capitol. The Capitol serves as the seat of government for the United States Congress, the legislative branch of the U.S. federal government. It is located in Washington, D.C., on top of Capitol Hill at the east end of the National Mall. The building is marked by its central dome above a rotunda and two wings. It is an exemplar of the Neoclassical architecture style. (Photo credit: Wikipedia)

What next?

Of course 17 October 2013 is a technical default breach days only; because as most business people who experienced bankruptcy will attest to is the fact that you can continue to trade (on the goodwill of your creditors) beyond the point of being solvent, so long as those creditors continue to good-naturedly extend some further credit or payment terms to you.

What can clearly be observed from the Yield Curve for Treasury Bills (T-Bills) dated 30 days is that the spread between 30 September 2013 (at 0.10%) to the rate at 11 October 2013 (0.26%) has significantly increased and that the Yield Curve has become inverted. Normally the sign of a recession or other financial calamity to come.

Our question:

Will Thursday 17 October 2013 be D-Day (for Disaster or Domino-day) when the whole lot starts tumbling down again?

The first Yield Curve takes a snapshot view of the yield curves at the end of Q1 2011 and Q1 2012.
What is very noticeable is the fact that the overall yields for the end of Q1 2012 is significantly lower than a year ago. Taking a look at the at the 5 year T-Note yields as an example, the spread between the end of March 2011 (5Yr T-Notes at 2.24% ) and the end of March 2012 (5Yr T-Notes at 1.04%) was 1.20% down. The question is what factors drove down the ‘risk-free’ rate on US Treasuries?

However, turning our attention to the second graph below, indicates a slightly different perspective; and hence the title of this post. Has and is risk returning to the capital and stock markets to levels we previously experienced?

Not quite, is the short answer, because the spread between 31 December 2011 (0.83%) versus the 1.04% rate at the end of March 2012, only indicates an uptick of 21 basis points in the yield rate. The significance is not the percentage spread, but rather the direction of movement and we will continue our analysis at the end of Q2 2012 to establish whether the direction in Q1 2012 will be maintained into Q2 and beyond.

The final question to ponder is this:

Are we finally seeing the corner turned, or are there still significant risks in the global economy and sovereign debt markets to cause a few further after shocks in the months to come?

In yesterday’s article, “Where will all the new money come from?” we concluded the brief analysis with the Sovereign Debt Maturity profiles (otherwise known as the Debt Structure) of both the USA and Italy, noting how similar the two profiles looked at first glance.

Image via Wikipedia

Digging a bit deeper today, we would like to compare those charts to cliff edges. We trust that the sentiment of the article is that we perceive Central Banks across the globe fretting about the ‘New Money’ we were referring to. With general economic confidence waning and the outlook for a sustainable long-term solution to sovereign over (indulgence) spending fading, the landscape is looking very bleak at moment.

New money will have to be printed (Quantitative Easing or QE) if investors in the capital markets cannot be found to bear the burden of purchasing new Bond and Treasury issues.

Image via Wikipedia

Some headlines over the few weeks alluded to Bond auctions in Portugal, Italy and Spain being well supported (see related article at the bottom of this post), but these were not major refunding and roll-over exercises. Greece is continuing to be a welcome distraction for politicians and Central Bankers in both taking investor’s eye off the bigger problems coming along the line in Q2 2012 and in winning time to hopefully come up with a credible longer-term plan to reduce debt levels and then return to growth.

Auction Calendars

Let’s take a look at some of the crucial Sovereign Debt auctions coming up in the next few months:

The link below provides a time table schedule issued by the US Treasury for T-Bills, T-Notes, T-Bonds and TIPS, for at least the next six months.

To get the equivalent Eurozone calendar is not so easy. (Partly because each individual country issues Bonds, as there is no Central Eurozone issuer of Bonds, but at least a central purchaser, namely the ECB – European Central Bank)

Image via Wikipedia

We are currently investigating sources of information for Eurozone Sovereign Debt Bond auctions and will return to this theme in very near future.

In our previous analysis piece on the Erosion of Confidence in the Capital Market, we discussed the downward trend in US T-Bill since 2006. In today’s brief analysis piece we have expanded the time horizon to the last 10 years from the beginning of 2001 to the end of the second quarter in 2011 (being June 2011). The view is each quarter end point for both 1 and 10 Year US T-Bills for this 10 year period.

What is interesting about both the 1month, 1 Year & 10 Year charts is the steady rise in rates (and economic confidence since the Iraq war in 2003 for both 1month and 1Year T-Bills). The Iraq war was declared on 19 March 2003 and this is the low point of the yield curves, followed by a steady rise in yield rates to their highest point (1 Year T-Bills) on 27 June and 18 July 2006 at 5.28% respectively.

The other point to note is the steady state of the 10 Year T-Bills between 2001 to 2006 bouncing around between 4% and 5% and then the steady erosion in returns since Q3 2006. As of 19 August 2011, 10Year T-Bills yielded a nominal 2.07% or a real (inflation adjusted) return of 0.02%.

The flight to more traditional bullion assets or other currency classes has been marked, with currencies such as the Swiss Franc, Canadian Dollar, Sterling Pound & Australian Dollar appreciating in value relative to the US Dollar as the flight to perceived safer haven assets classes and categories continue.

Our sister site (theVirtuousContinuum, launching on 26 August 2011) will have a more detailed briefing and analysis regarding the lack of Global coordinated Financial and Economic Leadership in order to stem the tide of confidence ebbing away in the global capital, commodities and wealth markets.

So it has finally happened. After threatening for months that a credit rating down grade was probable for the USA, Standard & Poor’s finally took the ‘big step’ on Friday 5 August, after the major markets closed.

Will the markets and market participants see the down grade as an opportunity to play an FX gain game; or has the game fundamentally shifted and will the capital markets react by demanding a higher nominal or at least Real Return on US Treasury bills?

All pointers at the moment did not indicate a problem, but time will tell on whether a fundamental shift in attitude has occurred. Remember a credit rating is only a qualitative indicator, not a quantitative one, so on a technical call a few FX traders and investors might make a profit or two; but we are all waiting to see if the entire game has changed, or not.

Other factors that might come into play soon would be QE3 and attitude hardening by major T-Bill investors.

And so too it is with economics. We don’t yet have a fully developed and ‘mature’ [in terms of life-cycle] grasp of the impact of timing with leads and lags in the economy in general.

Yes, we have very sophisticated and advance models, analytics, knowledge management, quantitative theories, etc.; but we still do not fully comprehend the impact of time and timing in general on the factors of production influencing our ‘modern’ global economy.

If only we could get the timing thing right and have a more insightful and meaningful (adult) debate not just in the US, but including global partners, both creditors and debtors alike.

But such is the nature of markets and spontaneous order, as espoused by our friends at the Austrian School, that we still believe and endorse the fact that ‘the market’ is still the best and most efficient mechanism for allocating resources (even financial and debt instruments) and informing the participants of potential risks and opportunities for clearing this market.

In the previous article we posted, mention was made of the (0.72)% [negative 0.72%] real return US Treasury investors can currently expect on 5 Year Treasury Bills. The Nominal (quoted) Yield Curves and Real (Inflation adjusted) Yield Curves for two specific points in time, namely Friday 29 July 2011 and 30 July 2006 are listed below.

Yield Curve 1

What is interesting to note is the very flat nature of the Yield Curve for all T-Bills at the end of July 2006, at around a 5% Nominal Return for investors. Yet the most significant fact is that the Real Yield was around 2.37% on 5 Year Treasuries, versus today’s (0.72)% on 5 Year or (0.18)% 7 Year T-Bill yields. In order to generate a very small Real Return, you have to be looking at purchasing a 10 Year T-Bill to obtain a modest 0.38% Real Return in today’s market.

A cynic might make this remark:

“Not only do you pay your taxes, but with the negative Real Yields on both 5 & 7 Year T-Bills, you are paying the government to hold on to your cash too”

As a general introduction today we will look at two US Treasury Yield curves. The first Yield curve in the Curve graphic 1 below is the 3 Month bills compared to the 10 Year bills over the last 5 years.

In this table it is clear that the current 10 Year rate of 2.82% as of 29 July 2011, is still well below the 5 year average rate. The trend of the 3 Month bills, especially over the last few months has drifted aimlessly between 0.15% on 28 February 2011 and currently at 0.10% on 29 July 2011. There is in fact no noticeable concern in the Bond / Capital market over the potential technical US Treasury default on 2 August 2011.

The second curve below in Curve graphic 2 illustrates this fact of the 3 Month bills trend since 28 February 2011 to 29 July 2011. As can be observed, in the last few days a very slight spike has been observed, yet the rate at 0.10% is still below the 0.15% rate of 28 February 2011.

Yield Curve 2

In real monetary terms it is costing 5 Year Treasury bill holders (0.72%) (Yes a negative return of 0.72% currently to buy 5 Year Treasuries. (See US Treasury web site)

It will be interesting to observe and track the trends over the coming days, especially as we kick off August and Debt Ceiling D-Day in the US congress and Senate.

In our previous article we highlighted the ‘battle royal’ on Capitol Hill to get a proposal agreed to address the possibility of a US Treasury default, whether actual or technical on or after 2 August 2011.

There is obviously a lot of back room dealing going on over this and analysts in Europe (taking their beading eyes off the Greek and now Italian and Spanish dominoes) have started to pay attention to the goings on across the pond. We heard one commentator mention the fact that the USA’ reputation has already been affected by this, irrespective of the fact that a default occurs or not.

So there you go. The fringe minority floating in the ‘Tea’ cup with a lack of the ability to look over the brim of that particular cup, might in fact achieve their overall objective of raising their own profiles, albeit at the expense of the nation’s reputation and standing as a pillar of the international capital market.

Look, we are not choosing sides here, because at the heart of the matter is the fundamental principles of civil society versus the public sphere debate raging and continuing to rage in the USA.

In our next article we will highlight some of the basic differences in opinion and views on the size and influence of government in the USA versus Europe, via the Rahn curve analysis.

Until then, it is tick, tock; tick, tock whilst we await the vote and subsequent consequences and fall-out from the US debt ceiling debate.

We are so very, very close to seeing and experiencing another colossal collapse in confidence in the world’s financial system.

This time it is driven by the ‘US Debt Ceiling impasse’. A steady flight to gold has been taking place over the past few months and even though most informed commentators believe the US Treasury ‘default scenario’ is not likely to physically occur, the mere threat of a default has not yet managed to ‘focus the minds’ of the US congress house of representatives locked in an ideological battle over fundamental economic policy and direction.

Image via Wikipedia

At stake here is a scenario that will make the 2008 financial crisis wane into insignificance, should the threat of a US Treasuries default actually play out.

If a default actually occurs, confidence in the international capital and currency markets will have been breached and no serious commentator has yet fully quantified or effectively mapped out the potential consequences of this potentially disastrous collapse in capital market confidence.

The only significant contribution we can make at this publication is to cross our fingers, hold as much in cash and liquid (non US dollar) assets and hope that some real focus and a meeting of minds occurs before Tuesday 2 August 2011 on Capitol Hill.